As China’s markets dominate headlines and many investors are concerned about the ripple effects of the weakness, I believe the current correction is a natural market movement that provides an opportunity to build on our portfolios at attractive prices.
Even after the recent and significant drops, the two main indices (Shanghai Composite Index and Shenzhen Component Index) in the country are slightly down, by 9%, year to date. The Chinese market is still roughly 30% above the low reached around the middle of last year. The Shanghai Composite Index closed at 2011 on May 9th, 2014 compared with a 2965 closing on Aug 25th, 2015 (Source: Bloomberg L.P.).
While this year’s correction certainly erased some wealth from the population in China, the broader impact on local spending is relatively small. The overall participation in equity markets in China is much lower than in developed markets. Less than 10% of the population in China invests in the equity markets, and most Chinese net worth is still tied to property markets. Therefore, the correction doesn’t have any material impact on consumption habits.
Hong Kong markets are driven by global capital market flow, which is what caused the upset in the last couple of months. However, Hong Kong is a highly liquid market. The forward price-to-earnings ratio (P/E) of the Hong Kong Stock Exchange (HKEx) is roughly 9.5 times – at the bottom of its average range for the last 40 years. It’s almost near the level reached during the global financial crisis.
After the most recent interest rate cut, China’s benchmark lending rate is now at 4.6%, leaving the country’s central bank plenty of room for further cuts. In this regard, China’s situation is quite different than other emerging markets right now. For example, Brazil and, to a lesser degree, India, have far less room to further cut interest rates due to inflation concerns in both countries. China is experiencing deflation, with excess industrial capacity.
The question then becomes, if they do cut interest rates further, what is the impact on currency?
The Chinese yuan has fallen by about 3%, which is a relatively minor fluctuation. The global reality is that the Chinese currency has been very strong for the last three to four years – second only to the U.S. dollar among major currencies (Source: Bloomberg L.P.).
With slower economic growth, I believe it’s only natural to have a weaker currency, which will help the country regain its competitiveness. This is particularly important for an export-oriented country like China.
Many currencies among the emerging markets are at 20-year lows, so the natural question is, “How low can they go from here?” Two interesting benchmarks for comparison are the global financial crisis of 2008 and the Asian financial crisis of 20 years ago. I think there is a very clear difference between now and either of those two periods.
In each of those cases, investors feared either a total crash of the global financial system or the meltdown of financial systems in regional markets such as Asia or Russia. During the Asian financial crisis, many emerging markets had exposure to U.S.-denominated debt, huge fiscal deficits and almost non-existent foreign reserves.
The situation is very different today. Many emerging markets have stuck to the lessons they learned and we are seeing much better fiscal situations with healthy foreign reserves in either U.S. dollars or euros.
As one who invests with Canadian dollars, I feel comfortable with the currency situation in China. The Canadian dollar has a decent correlation with the Chinese economy, so depreciation of the Chinese currency does not create a huge hit for Canadian-dollar investment accounts.
It always surprises me how short some investors’ memories are. It’s been just seven years since the last big downturn. Many of the people who panicked and sold their investments missed out on the massive gains that followed. I think times like this are when you should be investing – sticking to your guns. Most of the trades that we have made in the last few weeks have been buys among select Chinese and Brazilian companies.
Overall, I believe that investors that were interested in certain markets or funds three months ago should be really excited right now.
For a detailed look at the deleveraging process in China’s A-Share market and how Trimark funds that own Chinese companies are impacted, please read my earlier blog post, “Focus on quality shields Trimark funds from China’s A-share rout.”